After their locally incorporated entities were approved, HSBC, Citibank, Standard Chartered Bank and Bank of East Asia celebrated the opening of more than 100 retail outlets on April 2.

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Qualified overseas banks have formally gained permission, as required by China's World Trade Organization (WTO) membership, to provide financial services on an equal ground with domestic banks.

Many analysts think foreign banks will not pose a substantial threat to domestic commercial banks, nor will they create a big stir in the Chinese financial market.

Such blind optimism could hurt domestic banks if widely accepted by China's financial authorities and managers.

The optimists argue that foreign banks have occupied no more than 10 percent of the Chinese financial market since being allowed into the country years ago. As they see it, overseas banks are less competent than expected.

In fact, the whole picture should be reviewed to ascertain foreign banks' possible influence in China's financial market.

First of all, foreign banks in China have shown steady growth in market share, business revenues and numbers of retail outlets.

In a vast market like China, it is not likely that foreign banks will snatch a big portion of business within a few years. The total market share of foreign banks jumped from 1 percent in 2001 to about 2 percent in 2006. The growth is only a matter of one percentage point, but foreign banks have doubled their market.

China imposed various limits on foreign financial institutes when it was accepted into WTO in 2001. Foreign banks inched forward before the limits expired at the end of China's five-year transition period in late 2006.

A closer look should be taken into the market share occupied by foreign banks in specific business fields.

To keep a competitive edge, foreign banks try to focus on several categories of financial services in which they have better expertise or from which they can make bigger profits. Such categories include intermediate businesses in foreign currency and money management. In some coastal regions, foreign banks have already overwhelmed domestic banks in dealing with certain businesses.

Looking beyond current market share, foreign banks have many advantages over their Chinese competitors, which comes from their core competence.

Usually, foreign banks have stricter managerial policies, a more flexible business mode, better designed financial products and services, and staff with better professional skills than most Chinese banks.

Chinese banks also surpass local banks in designing financial products and services.

One of the skills is the pricing mechanism for bank loans. As the most important source of bank profits, loans should have appropriate interest rates based on a variety of factors. Few Chinese banks are knowledgeable in setting interest rates.

The ignorance in this regard is an outcome of the authorities' long-time strict control over interest rates. Even after the central bank widened the band for interest rates, commercial banks still do not compete with each other on loan rates.

Most domestic commercial banks offer similar services and products at similar prices and earn revenues at similar levels.

The situation is set to change as the interest rate and the exchange rate are both on their way toward being opened to market forces. It will be necessary for banks to set different loan rates for customers with different risks.

Without significant progress in mastering financial know-how, domestic banks will hardly keep the upper hand in competing with foreign banks.

Chinese commercial banks lack innovative capability. They do not have strong incentives to devise unique products and services, nor do they have enough qualified personnel for this challenge. Of course, Chinese banks are also subject to relatively rigid regulation, which, to some degree, has limited innovation.

By contrast, foreign banks are strong in offering diversified products and services for a variety of customers and adapting themselves to specific customer needs.

Admittedly, Chinese banks have their own advantages.

They have an extensive network of outlets around the country serving a vast network of customers. But this precious asset could turn poisonous if not well managed since retail outlets are expensive to operate. Banks will be heavily burdened if the retail outlets do not attract enough business revenue.

Chinese banks also have a better understanding of customers and the Chinese business culture. But this advantage over foreign banks may not persist long. Foreign banks can grasp a better understanding of local customers by localizing. And the localization of foreign banks began years ago.

As China lifts more restrictions on foreign banks, the Chinese banks should be objective in evaluating themselves as well as their overseas competitors. While it is foolish to be overconfident, there is no need to panic. A fair conclusion will only be drawn by cool minds.

The author is a senior economist with Galaxy Securities Co Ltd, China's largest securities firm

(China Daily 04/09/2007 page4)

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